Marijuana Is a Challenging Market

marijuana industry

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  • The next investment boom appears to be in sight. It’s in marijuana. This strikes many investors as a self-evident truth and an investment that seems likely to deliver large gains for investors willing to accept the new industry.

    Marijuana is a growth industry, with established demand and now a supply that is increasingly becoming legalized. The legalization could fuel more demand and that could make it an even bigger business opportunity and an even better investment opportunity.

    Booms always seem like they should be easy to trade. And, sometimes, they can be. The Internet bubble seems like it was one of those periods when trading was easy, for a time. In 1999, almost any stock which included .com in its name or with a business on the internet went up.

    But, this boom didn’t last long. There were many examples of stocks rallying sharply only to fall just as sharply, if not more so, within weeks. Although the trading thesis seemed to be simple enough, buying businesses that would disrupt existing businesses, it was difficult to implement.

    The same process played out less than ten years later in the housing market when home prices boomed and flipping homes seemed like a simple and foolproof path to profits.  The chart below shows that investment thesis worked for a while, but a bear market hit and many investors lost money.

    home price index

    Source: Federal Reserve

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  • The Next Big Boom

    Well, it seems as if there is always a boom in some market and for now, a candidate for the boom sector is marijuana. Many states and even countries like Canada are legalizing the use of marijuana, bringing a multi-billion dollar business out of the shadows.

    Again, the investment thesis sounds like it should be simple. There are millions of customers basically lining up to spend billions of dollars in a new market and this seems like it simply must be a profitable opportunity.

    One chart from Canada can put the potential demand into perspective: “The country’s eight biggest weed companies will require more than 8 million square feet of space for growing marijuana by 2020, up more than fivefold from current levels, according to a report from brokerage Jones Lang LaSalle Canada.”

    projected marijuana demand

    Source: Laef2Go.ca

    This chart demonstrates the expected demand and how rapidly the business can grow. This appears to be the perfect setup for explosive growth in the industry, large profits and tremendous returns for investors. But, this investment thesis is turning out to be as challenging as other booms.

    It turns out the laws of supply and demand still hold, even in new markets. As businesses move to meet consumer demand, they are creating more supply. This is an important part of the development of the market, but in economic terms it means the equilibrium price is likely to be at a lower level.

    While it was illegal, marijuana prices were relatively stable. The chart below shows the long term trend in prices in Canada over more than 50 years.

    cannabis price

    Source: ZeroHedge.com

    The price began to drop as the legalization movement accelerated. This fact, by itself, makes some sense.

    When a good is illegal, the retail price should reflect the factors of supply and demand and a premium for the risks associated with sales and distribution. Risks to suppliers in an illegal industry include risks associated with any business, but also legal risks that could mean a loss of freedom.

    Legalization reduces that premium and pricing. This is one factor reducing the price. Another is the increased supply. As businesses act to meet demand, they are risking a reduction in the price.

    In Colorado, one of the first states to legalize recreational use of marijuana, prices are down by more than 50%.  This means the investment thesis is no longer simple.

    Legal Issues Also Cloud the Investment

    One example can be seen in the stock of GW Pharmaceuticals PLC (Nasdaq: GWPH).

    GWPH daily chart

    The company recently received approval for its anti-seizure drug Epidiolex which is based on cannabidiol (CBD). And, the stock sold off on that news. But, now the difficult step begins.

    Even with approval from the Federal Drug Administrations (FDA), the company cannot market the drug until the Drug Enforcement Administration (DEA) approves of the distribution.

    The problem is that marijuana is a Schedule I drug which the DEA defines as “drugs, substances, or chemicals are defined as drugs with no currently accepted medical use and a high potential for abuse.” This includes marijuana, and other drugs like heroin and LSD.

    And, that highlights the biggest problem for the pharmaceutical industry. Federal law trumps state laws and places a cloud over the industry. In the case of GWPH, the drug could end up getting FDA approval but never being approved for sales.

    Now, there are risks. That is true for any investment. But, this is a new market and there will almost certainly be marijuana millionaires. These millionaires could include both the business owners and the shareholders. However, the shareholders must pick the right companies.

    The right companies could also change over time. This is a young and dynamic industry. It will be important for investors to avoid companies like Walden Books, a once ubiquitous book seller with locations in malls all around the country.

    It will be important to find the Amazon of marijuana, or the company that is able to adapt to changing consumer trends and a dynamic legal environment. This is a great opportunity and could also be the most challenging environment for stock market investors since the internet bubble of the late 1990’s.

    There will be winners and losers and times when some companies soar while others languish. In short, it will be like other volatile sectors.

    But, marijuana is likely to make millionaires out of investors who make the right trades. We’ve put together a special report that can help you navigate this emerging market. You can access that report by clicking right here.